Who do trustees in bankruptcy represent?

Since the credit crisis, we have all been subject to more advertising from trustees in bankruptcy about their services. The ads typically follow the same pattern of emphasizing a pain point (stress caused by the inability to pay off debts) and a solution (hire a trustee in bankruptcy) who offer a value proposition (e.g. “we are here for you”).

But is this advertising true?

One of the most misunderstood parts of the bankruptcy process is who the trustees in bankruptcy represent. When an individual declares or is assigned into bankruptcy, their assets are put into a legal fiction known as the bankrupt estate. It is the trustee in bankruptcy’s job to administer the estate.

In a “straight” consumer bankruptcy, typically defined as a liquidation of the bankrupt estates’ assets less any exempt assets (a non Division I or II Proposal bankruptcy filing in Canada or a Chapter 7 filing in the United States), the trustee represents the creditors in the collection and disposing of assets in the estate for distribution to the creditors.

In plain English, the trustees are, by law, required to act in the interests of the creditors even though it is the bankrupt who pays for the trustee’s services. Since in a straight bankruptcy, there is often very little to distribute, the trustee in bankruptcy is often looking for transactions which run afoul bankruptcy laws (mainly, gifts to non-arm’s length parties, payment of creditors out of the order of priorities, hiding of monies etc.).

In a restructuring (a Division I or Division II proposal in Canada and a Chapter 13 filing in the US), the trustee continues to represent the creditors. However, the person who files the reorganization continues to have control over their assets (unlike a straight bankruptcy where the trustee takes control of the bankrupt’s financial affairs); the trustee is, practically speaking, more co-operative and supportive of the debtor.

Keep in mind though that the trustee in a reorganization may work on contingency based on a percentage of debt collected. Thus, their financial incentives may run counter to the debtor.

The point is not to avoid a trustee in bankruptcy. In some filing, one has to hire a trustee in bankruptcy. Instead, be aware of who the trustee is representing.

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